This lesson focuses on the Consumer Price Index (CPI) and rate of inflation reported February 19, 2010, by the U.S. Bureau of Labor Statistics for the month of January, 2010. Students will read the BLS report, read about the meaning of the CPI, determine the change in consumer prices, and explore how the change in the CPI impacts consumers and the economy.

Current Key Economic Indicators

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in February on a seasonally adjusted basis. Over the last 12 months, the all-items price index was unchanged. The energy index increased after several months of decline. Core inflation rose 0.2% in February, the same increase as in January.

The unemployment rate stayed at 5.5% in March, 2015, according to the latest release from the Bureau of Labor Statistics on April 3, 2015. The number of jobs added was much lower than in previous months, with only 126,000 new jobs added to the economy, the fewest number since December of 2013. Some job categories added workers, including health care, professional and business services, financial services, and retail. Average hourly wage growth was 7 cents, but average hours worked fell.

Real GDP increased 2.2% in the fourth quarter of 2014, according to the final estimate released by the Bureau of Economic Analysis. This estimate is consistent with the revised estimate. In the third quarter, real GDP increased 5.0%. Consumer spending rose 4.4%, compared to 3.2% in the third quarter. Business investment and exports also increased. Offsetting these gains were increases in imports and decreases in federal government spending, particularly defense spending. (

In its March 18, 2015, statement, the FOMC cited the continued growth of the labor market, increased household and business spending, and below-target inflation as indicators of an economy that continues to recover. They expect below-target inflation to rise as oil prices increase in the medium term. The statement reaffirmed the FOMC intention to keep the federal funds rate at its current low level, but also said that a rate hike was highly unlikely at its April meeting. Notably, the FOMC dropped the word "patient" from its language describing its stance on an improving economy and a rate hike. The Fed revised downward its economic projections, including the rate of unemployment that would sustain a stable inflation rate.

INTRODUCTION

Each month, the U.S. Bureau of Labor Statistics (BLS) releases an estimate of the level of the consumer price index (CPI) and the rate of inflation in the United States for the previous month. The report provides the most recent current and seasonally adjusted consumer price indexes for all urban consumers, urban wager earners, and the chained index, plus a breakdown by major expenditure groups. The BLS also collects price level data for major metropolitan areas and regions.

This lesson focuses on the February 19, 2010, BLS press release of data on the consumer price index for the month of January, 2010.

During the second semester of this school year (Janaury-May), EconEdLink will publish five lessons on "Consumer Price Index and Inflation." During this time period, the Focus on Economic Data will begin with the "basics" in January and progressively focus on more complex data, issues, and comparisons. All monthly lessons will include the current data and significant recent changes.

January: CPI and inflation (deflation) basics: What is the CPI? What is inflation and deflation? How are they measured? What do they mean?

February: Details and issues about the measurements and meaning of the measurements of the price level, adding additional concepts. (THIS LESSON)

March: Detailed breakdown of the data by region and other criteria (trends, identifying trends and comparisons of regions and demographic groups).

April: The relationships of CPI and inflation data to other economic data, such as GDP, employment. etc. and the business cycle.

How to Use the Consumer Price Index for Escalation: This page provides an online fact sheet explaining how to use the CPI for escalating contracts.www.bls.gov/cpi/cpi1998d.htm

CPI-Why the Published Averages Don't Always Match an Individual's Inflation Experience: This page attempts to explain that CPI is an average, and each person's experience will differ.www.bls.gov/cpi/cpifact5.htm

How BLS Measures Price Change for College Tuition and Fees in the Consumer Price Index: This BLS page will be a great asset for students interested in saving money for college.www.bls.gov/cpi/cpifacct.htm

Key Economic Indicators

On a seasonally adjusted basis, the January Consumer Price Index for All Urban Consumers (CPI-U) rose 0.2 percent, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the index increased 2.6 percent before seasonal adjustment.

The U.S. unemployment rate fell from 10.0 to 9.7 percent in January and nonfarm payroll employment was essentially unchanged (-20,000). Employment fell in construction and in transportation and warehousing, while temporary help services and retail trade added jobs.

U.S. real gross domestic product increased at an annual rate of 5.7 percent in the fourth quarter of 2009, according to the "advance" estimate released by the
Bureau of Economic Analysis. In the third quarter, real GDP increased 2.2 percent.

The FOMC will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

PROCESS

“On a seasonally adjusted basis, the January Consumer Price Index for All Urban Consumers (CPI-U) rose 0.2 percent, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the index increased 2.6 percent before seasonal adjustment.”

The relatively small increase in consumer prices was good news for the U.S. economy. In the previous week, the Federal Reserve had increased the discount rate, the interest rate the Fed charges depository institutions that borrow reserves from it. This change in recent interest rate policy may have been a signal of inflationary pressures, but was most likely simply a move to the more "normal" relationship between the discount rate and the federal funds rate. Most analysis saw this as normalization, rather than reaction to any specific problems or a reversal of recent low interest rate policies aimed at stimulating the slow economy.

“The seasonally adjusted increase in the all items index was due to a rise in the energy index. An increase in the gasoline index was the main factor, and the indexes for fuel oil and natural gas rose as well, though the electricity index declined.”

Again, energy was the "wild card" in the computation of the overall price index. The BLS went on to explain the relationship between energy and other prices, comparing the overall price level index to the "core" index. Minus energy, the price level decreased.

“The index for all items less food and energy fell 0.1 percent in January. This decline was largely the result of decreases in the indexes for shelter, new vehicles, and airline fares. In contrast, the medical care index posted its largest increase since January 2008, and the index for used cars and trucks increased significantly for the sixth month in a row.”

The BLS normally points out any significant sectors where prices have risen or fallen. In this case, the specific comments were about food prices.

“The food index increased in January, with the food at home component posting its largest increase since September 2008. Sharp increases in the indexes for dairy and related products and for fruits and vegetables accounted for most of the increase.”

After the introductory "highlights" of the monthly announcement of the CPI. the BLS adds the details by breaking down the data by specific groups. Figure 1, below, lists the price level changes by major product group between December 2009 and January 2010, and for the year between January 2009 and January 2010.

Figure 1: Percent Change in CPI -- All Urban Consumers
U.S. City Average
January 2010

January 2010

12 mos.
Jan. - Jan.

All Items

0.2

2.6

Food

0.2

-0.4

Food at home

0.4

-2.0

Food away from home

0.1

1.6

Energy

2.8

19.1

Energy Commodities

4.9

46.6

Gasoline

4.4

51.3

Fuel Oil

6.1

19.3

Energy Services

0

-4.7

Electricity

-1.1

-1.9

All items less food and energy

-0.1

1.6

New vihicles

-0.5

4.1

Used cars and trucks

1.5

11.5

Apparel

-0.1

1.7

Medical care commodities

0.7

3.5

Shelter

-0.5

-0.1

Transportation services

-0.3

3.3

Medical care services

0.5

3.5

[NOTE: The monthly (December to January) increase is seasonally adjusted.The annual (January to January) change is not seasonally adjusted.]

[Note to teachers: Student may be interested in looking at the price change of the items in their own "market basket." The BLS CPI Detailed Report
breaks down the data by very specific categories on this web site.]

Seasonal Adjustments

"Seasonal adjustment removes the effects of recurring seasonal influences from many economic series, including consumer prices. The adjustment process quantifies seasonal patterns and then factors them out of the series to permit analysis of non-seasonal price movements. Changing climactic conditions, production cycles, model changeovers, holidays, and sales can cause seasonal variation in prices. For example, oranges can be purchased year-round, but prices are significantly higher in the summer months when the major sources of supply are between harvests." Source: BLS, Fact Sheet on Seasonal Adjustment in the CPI
.

According to the BLS, "Those who use the CPI in escalation agreements to adjust payments for changes in prices should typically not use seasonally adjusted indexes. Unadjusted indexes are used extensively for escalation purposes because they measure the change in actual prices consumers pay for goods and services. Many collective bargaining contract agreements and pension plans, for example, tie compensation changes to the Consumer Price Index unadjusted for seasonal variation."

[NOTE: Indexes for the post-2007 period may be subject to revision at some time in the future.]

The BLS uses several different measures of the CPI for specific reasons. Each is appropriate for given demographic groups.
Consumer Price Index for All Urban Consumers (CPI-U)

The all urban consumer group represents about 87 percent of the total U.S. population. It is based on the expenditures of almost all residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers. The CPI for All Urban Consumers (CPI-U) is the index most often reported by the national media.

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is based on the expenditures of households included in the CPI-U definition that also meet two requirements: more than one-half of the household's income must come from clerical or wage occupations, and at least one of the household's earners must have been employed for at least 37 weeks during the previous 12 months. The CPI-W population represents about 32 percent of the total U.S. population and is a subset, or part, of the CPI-U population. The CPI for Urban Wage Earners and Clerical Workers (CPI-W) is the index most often used for wage escalation agreements.

The CPI inflation calculator allows customers to calculate the value of current dollars in an earlier period, or to calculate the current value of dollar amounts from years ago.

Consumer price indexes often are used to escalate or adjust payments for rents, wages, alimony, child support and other obligations that may be affected by changes in the cost of living. There is a fact sheet explaining how to use the CPI for escalating contracts.

From January 2009 to January 2010, gasoline prices increased by 51.3% and fuel oil prices increased by 19.3%

The Producer Price Index for Finished Goods rose 1.4% in January, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. This increase followed a 0.4% advance in December and a 1.5% rise in November. In January, at the earlier stages of processing, prices received by manufacturers of intermediate goods climbed 1.7%, and the crude goods index jumped 9.6%. On an unadjusted basis, prices for finished goods moved up 4.6% for the 12 months ended January 2010, their third consecutive 12-month increase.

Chained Consumer Price Index for All Urban Consumers (C-CPI-U)

The C-CPI-U supplements the other two CPI indexes. The C-CPI-U is designed to more closely resemble a true "cost-of-living index" by taking into account observed consumer behavior, technological changes, and product substitutions. The C-CPI-U is chained monthly, using expenditure data to average price changes across item categories between a base period (1999, initially) and the current period. Data are national, not seasonally adjusted, and subject to revision.

The CPI may not be applicable to all population groups. For example, the CPI-U is designed to measure inflation for the U.S. urban population and thus may not accurately reflect the experience of people living in rural areas. Also, the CPI does not produce official estimates for the rate of inflation experienced by subgroups of the population, such as the elderly or the poor.

Recent History of the Consumer Price Index

Since 2000, the U.S. economy has experienced relatively low annual rates of inflation. The "wild card" has been energy prices. which have fluctuated much more widely than the overall price level. In the last quarter of 2008, the CPI-U dropped 3.3 percent and 1.3 percent from September 2008 to September 2009. 2009 has seen very low monthly increases in the CPI. Figure 1 show the monthly changes in the CPI-U from 2002 through September 2009. Note the erratic pattern of changes month to month. Many of the shifts from increase to decrease and decrease to increase reflect short-term changes in energy prices.

Producer Price Index (PPI)

The Producer Price Indexes (PPIs) are a group of price indexes that measure changes in the selling prices received by domestic producers of goods and services. They formerly were referred to as Wholesale Price Indexes. When the PPIs are released, the news media will most often report the percentage change in the Index for Finished Goods.

On February 18, 2010, the BLS reported on the producer price index from the month of January, 2010. "The Producer Price Index for Finished Goods rose 1.4 percent in January, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. This increase followed a 0.4-percent advance in December and a 1.5-percent rise in November. In January, at the earlier stages of processing, prices received by manufacturers of intermediate goods climbed 1.7 percent, and the crude goods index jumped 9.6 percent. On an unadjusted basis, prices for finished goods moved up 4.6 percent for the 12 months ended January 2010, their third consecutive 12-month increase."

The Gross Domestic Product (GDP) Deflator

The GDP deflator (also called the implicit price deflator (IPD) is a measurement of inflation that tells how much the price of all goods and services included in GDP have increased. GDP includes consumer goods and services and also machinery and equipment bought by firms, purchases of goods and services by government, and the impact of exports and imports. The "deflator" is the ratio of the current-dollar value of a series, such as gross domestic product (GDP), to its corresponding chained-dollar value, multiplied by 100. In other words, the GDP figures are adjusted for inflation using the deflator.

The Bureau of Economic Analysis uses the raw data on production to estimate nominal GDP (GDP in current dollars). The BEA then adjusts the data for inflation to arrive at "real GDP."

"The CPI is the most widely used measure of inflation and is sometimes viewed as an indicator of the effectiveness of government economic policy. It provides information about price changes in the Nation's economy to government, business, labor, and private citizens and is used by them as a guide to making economic decisions. In addition, the President, Congress, and the Federal Reserve Board use trends in the CPI to aid in formulating fiscal and monetary policies."

"The CPI frequently is called a cost-of-living index, but it differs in important ways from a complete cost-of-living measure. BLS has for some time used a cost-of-living framework in making practical decisions about questions that arise in constructing the CPI. A cost-of-living index is a conceptual measurement goal, however, and not a straightforward alternative to the CPI. A cost-of-living index would measure changes over time in the amount that consumers need to spend to reach a certain utility level or standard of living. Both the CPI and a cost-of-living index would reflect changes in the prices of goods and services, such as food and clothing, that are directly purchased in the marketplace; but a complete cost-of-living index would go beyond this role to also take into account changes in other governmental or environmental factors that affect consumers' well-being. It is very difficult to determine the proper treatment of public goods, such as safety and education, and other broad concerns, such as health, water quality, and crime, that would constitute a complete cost-of-living framework."

[Note to teacher: The "Virtual Economics" CD includes a basic explanation of "inflation" through a video clip. If you have a copy of "Virtual Economics," open the "Browse Economics Concepts" section and click on the key word "inflation" in the macroeconomics section.]

The "Core" Rate of Inflation and the "Headline" Rate

"The 'core' CPI measurement represents changes in the consumer price index minus items which typically fluctuate widely from month to month - food and energy. From the January 19 BLS announcement: " The index for all items less food and energy fell 0.1 percent in January. This decline was largely the result of decreases in the indexes for shelter, new vehicles, and airline fares."

Extra attention is given by forecasters to the core index as it tends to show more lasting trends in prices. The rates of change in the core index were higher in the early part of the year and that did cause concern about the trend in inflation. The concern was that the increase in energy prices over the last several years may have started to influence rates of increases in all other prices. While that concern still exists, core prices are increasing at relatively slower rates.

The "headline" rate - the rate reported in the media includes energy and food. Adding the more volatile energy and food prices often shows greater rates of change. In some cases, a drop in energy prices added to inflation in other categories will end up showing a net "no change."

Calculating the Rate of Inflation Over a Period of Time

The CPI Inflation Calculator
allows customers to calculate the value of current dollars in an earlier period, or to calculate the current value of dollar amounts from years ago. The CPI inflation calculator uses the average Consumer Price Index for a given calendar year. This data represents changes in prices of all goods and services purchased for consumption by urban households. This index value has been calculated every year since 1913. For the current year, the latest monthly index value is used.

Consumer price indexes often are used to escalate or adjust payments for rents, wages, alimony, child support and other obligations that may be affected by changes in the cost of living. Escalation agreements often use the CPI—the most widely used measure of price change—to adjust payments for changes in prices. The most frequently used escalation applications are in private sector collective bargaining agreements, rental contracts, insurance policies with automatic inflation protection, and alimony and child support payments.

Open the calculator and put in the time period since your year of birth to today. How much inflation have we experienced in your lifetime? If your parents bought a new car for $15,000 the year you were born, what would that car cost in today's dollars?

ASSESSMENT ACTIVITY

Short Answer Question

1. How does inflation impact your life?

[Students should be able to connect their spending patterns to price level changes. One common comment should be about gasoline prices over the past year. Students may also commonly comment on changes in the prices of apparel and entertainment. They should use the terminology of the CPI (as found in this lesson) accurately.]

CONCLUSION

Inflation is not a serious threat to the U.S. economy at this time. This seems to be the consensus of most observers and analysts. Some, though, think that continuing budget deficits and stimulatory spending will eventually result in higher prices. The Federal Reserve stands ready to reverse its low interest rate policies if inflation seems to be a threat. As of now, policies that stimulate spending and increasing the money supply have not resulted in significant inflation. As usual, energy prices are the primary unknown variable for future predictions of inflation.

The BLS reported in February, "...the January Consumer Price Index for All Urban Consumers (CPI-U) rose 0.2 percent" and "...over the last 12 months, the index increased 2.6 percent before seasonal adjustment.” The primary reason for the annual increases was energy price increases. On July 14, 2008, U.S. regular gasoline prices averaged $4.05 per gallon. By July 13, 2009, the average price of regular gas had dropped below $2.47per gallon. On January 11, 2010, the average price of a gallon of regular gasoline was back up to $2.71.

[Note to teachers: Students may be very interested in further discussion of the history of gasoline prices. Go to the Energy Information Administration web page: Retail Gasoline Historical Prices
.]

Do you think inflation is a threat?

EXTENSION ACTIVITY

The BLS provides more detailed information about how price level changes are measured for different demographic groups, sectors, and specific product groups.